Following a challenging day that saw U.S. stocks drop into correction territory, the main indexes are recouping some of yesterday's losses in early afternoon trading on Thursday, with the Dow Jones Industrial Average (^DJI +0.36%) and the S&P 500 (^GSPC +0.44%) up 1.38% and 1.44%, respectively, at 1 p.m. EST. The Nasdaq Composite Index is up 2.69%.
All three major indexes were in correction territory at yesterday's close -- in Wall Street patois, a correction decline in excess of 10% relative to the high. Meanwhile, the 3.3% daily decline in the Russell 2000 put the benchmark index for small-capitalization U.S. stock into bear market territory, down 23% (a bear market requires a minimum 20% fall in stock prices).
The fact that small-cap stocks have been hit so hard is not particularly encouraging, as it lends weight to the notion that this market has recently been powered by large gains in a small number of large-cap names, including the so-called FANGs: Facebook, Amazon.com, Netflix and Google (yes, strictly speaking, it's Alphabet Inc, but that doesn't produce a snappy acronym).
When gains are not widely distributed, this makes market-watchers nervous, as it conjures up the image of an edifice that lacks robust foundations (although the important question is not necessarily how many names are driving the market, but how those names are presently valued).
I have absolutely no idea how to forecast what the stock market will do over the next week, month, or year (in other words, I'm equally knowledgeable as Warren Buffett on that topic). However, I like to look forward (and backward) over longer time horizons, where the average and reversion toward that mean begin to dominate volatility.
This is how the modern-day S&P 500 has performed over its near 59-year existence:
- Annualized price return: 6.7%
- Annualized total return: 10.1% (includes reinvested dividends)
(The S&P 500 in its present form began on March 4, 1957; the returns above are presented from the end of that month. This is as good a starting point as any to begin tracking long-term stock market returns, because the market was then roughly fairly valued.)
More recently, this is how the index has performed over the five- and 10-year periods through the end of last week:
|
|
Trailing 5 Years |
Trailing 10 Years |
|---|---|---|
|
Annualized Price Return |
8.6% |
4.1% |
|
Annualized Total Return |
10.9% |
6.2% |
Source: Author's calculations, Bloomberg.
The mediocre returns over the past decade are owed to an inflated starting valuation -- stocks were already overvalued in early 2006, as the credit bubble was starting to move into high gear. More concerning, however, are the above-average returns earned over the past five years when it's far from clear that the S&P 500 began that period undervalued.
More so than the stock market correction, last year's performance, disappointing as it was, is a better indication of what we might expect regarding the next five years: Returns below the historical average that would bring 10-year returns closer in line with historical returns (see the first table).
On the bright side, at least you didn't purchase a winning ticket for the Powerball lottery that would have given you a share of the $1.6 billion jackpot. Do you really think you could control yourself with those sort of sums? Following an initial bout of exhilarating spending, my guess is that most winners aren't happier 10 years on (and I expect a significant number end up much less happy).
